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The Market Will Only Care About 1 Thing When Netflix Reports Earnings Next Week

There are plenty of numbers investors will be watching, but when it comes right down to it, there's really only one that matters.

Even after a significant decline following last quarter's rare subscriber miss, Netflix(NASDAQ:NFLX) is still up an impressive 82% so far this year -- though it had been up as much as 118%. Investors in the streaming pioneer have been cautiously optimistic that the company can return to its winning ways, but fearful that the slowdown in paying customers could be the beginning of a longer-term downward trend.

All eyes will once again be on the subscribers when Netflix reports the financial results of its 2018 third quarter on Tuesday, October 16, after the market closes. Let's look at the results from the company's most recent quarter and review the expectations for its upcoming earnings release.

Image source: Netflix.

Will momentum return?

Going back to the days of its DVD-by-mail delivery service, Wall Street has always gauged Netflix's success by its ability to maintain its subscriber growth rates. After posting record-setting results in the first quarter, the reality fell short of expectations in the second quarter.

For the three months that ended on June 30, Netflix reported net subscriber gains of 5.15 million, far short of the 6.2 million it guided for. It wasn't that the results were all that bad, but that the company rarely missed its own forecast. Revenue of $3.9 billion increased 40% year over year, while earnings per share of $0.85 soared 467%. For most companies, that would be reason to pop open the bubbly -- but this isn't most companies. It's Netflix.

A little perspective is in order...

It's important to note that Netflix offered the following perspective regarding its forecasting process: "The quarterly guidance we provide is our actual internal forecast at the time we report and we strive for accuracy, meaning in some quarters we will be high and other quarters low relative to our guidance," CEO Reed Hastings said in a letter to shareholders.

Taking a wider view may provide some additional clarity. By adding Netflix's forecasts for the two most recent quarters and comparing to the actual subscriber gains, it shows that the company's aggregate forecast for the two quarters was almost dead on:

It's also important to point out that Netflix reported a similar miss in its seasonally weak second quarter in 2016, when the company delivered 1.7 million new subscribers -- compared to the 2.5 million it expected -- and the stock fell by more than 14% in response. But has gone on to gain more than 300% since then.

The metrics to watch

For the third quarter, Netflix forecast the addition of 5 million net new subscribers, with expectations for 4.35 million international customer gains and 650,000 domestic additions. This would bring the company's total subscriber count to 135.14 million, up 24% year over year.

Netflix expects revenue of about $3.988 billion, an increase of 33.6% compared to the prior-year quarter. The company is forecasting net income of approximately $307 million, and earnings per share of $0.68, an increase of 134% compared to the year-ago period. Another area to watch is operating margin, which Netflix expects to be 10.5%, a 50% increase year over year. Analysts are also expecting solid growth, with consensus estimates calling for revenue of $4 billion, and earnings per share of $0.68, both in line with the company's expectations.

Netflix has had an uncanny ability to under-promise and over-deliver, and it has very rarely missed its own forecast. I don't believe it will happen again this quarter, but we'll know for sure on Tuesday.

Author

Daniel W. Vena, CPA, CGMA is long-term investor searching for intangibles that provide explosive growth opportunities in his investments. He served on active duty with the US Army and has a Bachelors degree in accounting.
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